Posted by Shyam Moondra
In 2011, I predicted that DJIA was headed to 18,000 (“We are in a secular bull market - DJIA headed to 18,000,” The Moondra Post, March 14, 2011) and it looks like we are on track to achieve that record high by early 2014. Given that the current bull market is now more than five years old, many prominent analysts are predicting that a market crash of 10-20% is imminent. However, I believe that the bull run is not yet over.
The following trends favor a continuing up move in the stock market at least through March, 2014:
- The stock valuation is high but the market is definitely not overpriced. The forward PE of 15 for the DJIA, as currently estimated by WSJ, is by no means excessive compared to the high 20’s at the recent market peaks of 2000 and 2007. The market would look pricey if PE were to get close to high-teens, given that we are currently in a low-growth environment compared to the go-go years of the early 2000’s.
- Corporate profits continue to be at record levels, thanks to a superb job done by the corporate world in managing their cost-structure through the great recession in the aftermath of the financial crisis of 2008. Given that economy is currently strengthening (3Q13 GDP growth rate revised upward to 3.6%), further gains in corporate profits are predicted for 2014. Accordingly, there is room for continuing expansion of the PE multiples of the stocks.
- The unemployment rate has steadily come down to 7% from double-digit numbers at the height of recession, which means consumer spending would continue to increase in the foreseeable future. Also, increases in the stock prices and recovery in real estate prices have pushed the household wealth to record levels which would also guarantee increased consumer spending. Since consumer spending accounts for 70% of the economy, the economic activity would continue to be in high gear which would lead to further reduction in the unemployment rate, creating a sustainable upward spiral in GDP.
- Interest rates and inflation continue to be at low levels that always favor the stock market. In the near- to mid-term, we might see a spike in interest rates from the current 2.8% to 3.5% (on 10-year treasuries), but historically we would still be at relatively low levels. Since the corporations have a record cash hoard of the tune of $4 trillion, they may not have a huge need to borrow to support their capital expansion plans and thus the impact of higher interest rates on the economy could be somewhat muted.
- Currently, there is too much cash lying around in money market accounts and the stock market lacks euphoria which is typically seen at the market peaks (that's when stock prices go up sharply with heavy volume). That means the stocks have not yet peaked and that we would see a continued upward move in the stock prices.
- Europe and emerging markets are showing early signs of recovery after unprecedented austerity measures (taken to reduce budget deficits) devastated their economies. The U.S. recovery combined with recovery in Europe and emerging markets would give a further boost to global trade which would increase the U.S. exports and corporate profits.
- Finally, much has been made of the impending Fed tapering of their monetary stimulus program, QE3, in which the Fed buys government securities at a rate of $85 billion a month. The Fed has said that when economy improves and unemployment rate falls to 6.5%, they will phaseout monetary stimulus. The recent GDP growth rate of 3.6% makes it likely that the Fed would start tapering QE3 in 1Q14. Theoretically, QE3 tapering would have some negative impact on the stock market, but there would be some offsetting factors as well. As the interest rates increase in the face of tapering, the bond bubble would finally burst and some of the bond money would end up in stocks. Also, the underlying economy would be stronger and that means corporate profits would remain healthy. Therefore, tapering may not necessarily be a bad news and the fears of market crash are overblown.
Given the above global economic trends, there is a possibility that the DJIA might even surpass the 19,000 mark some time in 2014.
